S&P Global believes regional sovereigns and banks are in a good position to cope with the Israel-Iran escalations, with the agency laying out different scenarios for the conflict and how it could affect different players in the region, it wrote in a note on its website.

S&P sees four primary risks affecting regional credit conditions: Regional sovereigns and lenders could be affected by issues that include “broader confidence factors” — which could hamper economic growth, funding costs, and banking system liquidity and asset quality — as well as surges in the prices of energy, production, and transportation, weaker tourism and capital outflows, and other security-related expenditure, the agency wrote.

Outflows can be severe for the region: External funding outflows are expected to reach around USD 240 bn — equivalent to “about 30% of the cumulative external liabilities of tested systems.” However, S&P believes banks in the region have the necessary external liquidity to cover these outflows in most cases, provided their external assets can be liquidated.

The UAE is among the most likely to weather the outflow storm: UAE banks have the strongest net external asset position in the region at large, which makes them the most resilient in the face of potential capital outflows. However, escalatory attacks between Israel and Iran are expected to affect business confidence in the GCC region at large, according to S&P.

Key risks for GCC banking systems include:

  • Outflows of foreign funding, which would entail non-resident investors exiting the GCC region as tensions escalate;
  • Outflows of local funding, which could materialize only in the case of a broader regional conflict or in S&P’s “severe stress scenario” of a wider conflict involving regional and non-regional allies;
  • “A spike in default rates among banks’ corporate and retail clients,” which would come if there were disruptions to oil exports as part of the geopolitical instability.

Local private sector deposit outflows are expected to happen only under the agency’s most severe scenario of a wider conflict, and in the event of an exit of expats and residents. In that scenario, S&P expects 20% outflows of private sector deposits, which is based on historical data from the 1990-1991 Gulf War as a precedent. Meanwhile, the agency does not expect to see outflows of government or public sector deposits, saying that previous episodes of heightened geopolitical risk saw intervention from governmental and public entities to support banks amid capital outflows.

Even in the worst case scenario, banks in the GCC are equipped to cope with the losses: Banks are expected to experience some USD 290 bn in local private sector deposits under the worst case scenario posed by S&P, which the agency thinks banks can cope with. If there is less liquidity than originally assumed, central banks are likely to step in to support, the agency said.

Another risk for the UAE and the wider region is the potential blockage of the Strait of Hormuz, which S&P Global said would “disrupt regional cargo flows, particularly through Jebel Ali port in Dubai—a key hub in regional supply chains.”

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